PP 2009/69

In June, the Insolvency Service (IS) began consulting on proposals designed to support companies in financial difficulty. The consultation paper, Encouraging company rescue – a consultation, invited comments on proposals to: (i) extend the company voluntary arrangement moratorium against creditor action, which is available only to small companies; (ii) introduce a new court-sanctioned moratorium that would be available to all companies; and (iii) provide greater security for the repayment of loans to companies in financial difficulty to enable them to obtain rescue finance. One of the changes suggested in respect of rescue finance reflects Chapter 11 bankruptcy in the US. The IS proposes that administrators should be able to obtain rescue finance that, in certain circumstances, would take effect as a first charge ahead of, or equal to, other fixed charges. Legislative provision would allow the rights of negative pledge holders to be overridden in such cases. The IS believes that lenders will, as a result, be more willing to extend credit to companies in administration. However, it also recognises that its proposal could change lending practices and make funding for solvent companies more difficult to obtain. It therefore proposes a number of safeguards to protect existing charge holders.  Notice would have to be given, enabling existing charge holders to object if they would be adversely affected and, when considering whether to approve such a proposal, the court would have to decide whether, on balance, the interests of all creditors would be best served by the administrator’s decision.  Despite these suggested safeguards, the proposal has not been universally welcomed. In its response to the consultation, which closed in September, the Insolvency Lawyers’ Association described the proposal as “a serious erosion of proprietary rights”. Many of the respondents enquired whether it will apply retrospectively to charges granted before such legislation is brought into force and have drawn attention to Article 1 of the European Convention on Human Rights, which protects possessions.  The objections of the City of London Law Society are wide-ranging. It argues that the proposal would create serious uncertainty if the priority of a security could be altered at the point when it is most relied on. It is also concerned that lenders will be reluctant to make loans or will reflect the added risks in the price of funding, which may of itself force some companies into administration. It suggests that lenders may opt for alternatives, such as title transfer financing (under which title to the relevant asset would be vested in the financier), which would be cumbersome and expensive, and highlights the adverse effects on businesses, such as property companies, that are funded on a secured basis. It is also worth noting that unless they are specifically exempted from any future legislation, rent deposits, which provide a vital form of security for landlords, will be affected, as will overage agreements protected by legal charges over land. Allyson Colby is a property law consultant